Current M&A Climate in the PEO Industry

M&A Climate Opening

One of the most common questions we receive from PEO owners is “how is the current market for selling a PEO?” This article will give a high-level overview of what we are currently seeing in deals and what we forecast for the near-term future.

External M&A Climate Key Variables

Some key variables to keep an eye on if you are considering entering the market for a sale are the following:

1. Cost of Capital
2. Economic Trending
3. Supply & Demand

Cost of Capital: The cost of capital is increasing in the US. Deals that rely partly or heavily on debt financing may get more stringent in deal mechanics and/or diligence. While competition for good PEO assets is high, if a continuation of interest rates inclination occurs, we could see some slippage in valuations in the future.

Economic Trending: Economic trending affects valuations in multiple ways. If the economy is sluggish, existing clients and new client growth may be slowed due to reduced headcounts. Moreover, if the economy is sluggish, buyers will tighten their parameters on which deals they wish to pursue which could result in lower valuations for non-optimal targets.

Supply & Demand: There is still a supply and demand issue with larger PEO targets due to the consolidation movement over the past 15 years. As such, we expect larger desirable targets to hold their valuations more than regional players. However, with the cost of capital increasing and PE’s partial reliance on debt financing, it will be interesting to see how proposed deal mechanics may evolve.

Internal M&A Key Variables

For a full list of internal variables that drive valuation, visit our article titled Do You Know What Your PEO Is Worth?. High-level, see below for areas that will most certainly impact a PEO’s valuation (up or down).

1. Growth Trend
   1. Favorable growth trends = higher valuations.
   1. Declining growth or flat growth court lower valuations.
2. Profit Ratios
   1. Strong sustainable profit ratios = higher valuations.
   1. Low profit ratios or unsustainable profit ratios court higher scrutiny.
3. Risk Profile
   1. Low and/or controlled insurance risk profiles = higher valuations.
   1. High risk profiles court lower valuations and tail carve out deal mechanics.
4. Legal Liabilities
   1. Low/no legal liabilities = higher valuations.
   1. High legal liabilities cause concern for loose internal controls and can court lower valuations with higher deal scrutiny.
5. Client Concentration
   1. Low client concentration = higher valuations.
   1. High client concentration may not impact valuation but may court higher earn-out provisions.
6. Technology
   1. Integrated tech suites = higher valuations.
   1. Low-grade tech may not impact deal valuation but will be cause for integration risk concerns.
7. Client Segmentation
   1. Client segmentation depends on the buyer, but we are seeing an increased interest in blue-collar targets due to AI.
   1. The PEO value prop will need to align with chosen client segmentation.
8. Retention
   1. High historic client retention = higher valuations.
   1. Low historic client retention may court adverse deal mechanics such as earn-outs.
9. Geography
   1. Desired geographic presence = higher valuations.
   1. Tertiary markets for regional targets may cause headwinds for valuations.
10. Industry Concentration
    1. Low industry concentration and/or industries with low economic cyclicality volatility = higher valuations.
    1. High industry concentration prone to economic cyclicality can court lower valuations and/or earn-out provisions.

Summation of the M&A Market overview in the PEO industry

Deal values remain high for sellers, though increased scrutiny on deals is emerging as the cost of capital increases. PEOs that are optimal targets, based on the criteria in the section above, court the highest market valuations. Sellers that do not rank high, based on the criteria in the section above, may experience less favorable deal mechanics, lower valuations, and/or a smaller potential pool of buyers.

It is not advised to solely try and time the market with the sale of your business. You’re ready when you’re ready. However, market variables absolutely have an impact on PEO valuations. It feels like we are currently at the crescendo of a sellers’ market. How long the market will remain there is to be determined. However, with the cost of capital rising and an Economic Uncertainty Index around 250, if you are potentially considering a sale, it may be good timing to receive a valuation analysis through Business Resource Center, Inc. to understand the value of your PEO.

Author

Rob Comeau is the CEO of Business Resource Center, Inc., an M&A advisory firm with a niche focus on the PEO and surrounding industries.